Private Debt Slows The Euro Zone Recovery

Since the euro zone debt crisis has started more than two years ago, public debt has received most of the attention from the European policy makers. In the meantime, the growing private-sector debt has started to show its negative impact on the economy of many euro zone nations.

The private-sector debt problem originates from mortgages. Real-estate prices increased over the past years in a number of European countries, and banks were willing to lend ever-larger sums for home purchases. The real-estate boom has since hit the rocks throughout much of Europe, but the acquired mortgages continue to burden European consumers and weigh heavily on the economic recovery of these countries.

There is a strong link between consumption, credit booms and falling real-estate prices. Countries with a sharp rise in household debt during the housing boom experience a sharper fall in consumption after housing prices has began to decline.

Evidence of this effect is clear in Europe. In the Netherlands and Denmark, where debt levels rose sharply before the crisis, household consumption has fallen 3.3 percent and 3 percent respectively since 2008. In the UK, after a decade of sharply rising household debt, consumption has fallen 3.5 percent. Germany, which has not experienced such credit boom, consumed 2.4 percent more last year than they did in 2008.

The EU leaders continuously seek to identify ways to prevent housing bubbles and credit booms from spiralling out of control. But all these policies are geared toward prevention, rather than addressing the consequences of the existing problem.

While the European governments have yet failed to embrace bold policies that would ease the burden on the European economy, highly indebted European households will continue to slowdown the recovery of the EU nations.

Source: Wall Street Journal